"Life Cycle" Hypothesis of Saving: Aggregate ... - Arabictrader.com

Long-Run Implications of Alternative Fiscal Policies 89
Thus it would appear that the classical-burden position needs to be modified
to the extent of recognising that the burden of deficit financing consists not in the
increased taxes as such, but rather in the fall in income generated by the reduction
in the stock of capital. But this modification would seem rather innocuous,
since, admittedly, rdD will generally provide a reasonable approximate measure
of the true burden. In fact, however, the amendment we have suggested turns out
to have rather far-reaching implications as we will show presently.
VI Shortcomings of the Classical Transfer and Burden Argument:
The Differential Effect of Deficit Versus Tax Financing
The classical conclusion that deficit financing of an expenditure places the burden
on the future seems to imply that, if the expenditure were financed by taxes, there
would be no burden in the future. Interestingly enough, Buchanan’s book provides
nowhere a systematic treatment of the temporal distribution of the burden
from a tax-financed expenditure. Nor is this really surprising, for if the burden
were in fact the interest of the debt, then tax financing could generate no
burden on the future. 15 But if the relevant criterion is instead the loss of capital
formation, then in order to find the true differential effect of debt financing versus
tax financing, we must inquire about the effects of tax financing on private saving
and capital formation. Only if this effect were nil or negligible would the classical
conclusion be strictly valid.
Now, to an economist steeped in the Keynesian tradition, it is at once obvious
that raising taxes to finance the government expenditure cannot fail to affect significantly
private saving and capital formation. While tax financing will reduce
disposable income by the amount of the expenditure, it will reduce consumption
only by an amount cdT = cdG, where c is the marginal propensity to consume.
The rest of the tax will be borne by a reduction in saving by sdT, where s = 1 -
c is the marginal propensity to save. Accordingly, if the initial position was one
of full employment, as we are assuming, and inflation is to be avoided, private
capital formation must itself be reduced by the amount sdG (through the appropriate
monetary policy). 16 This outcome is illustrated numerically in row (c) of
table 3.1. By comparing the outcomes (a), (b) and (c) as is done in part B of the
table, we find that the differential effect of the deficit versus tax financing is to
decrease capital formation by dG - sdG = cdG. The balance of the reduction,
namely sdG, must be attributed to the expenditure as such, independently of how
financed. 17 Hence, even if we are willing to regard the interest rate paid by the
government as a good approximation to r*, the differential burden of debt financing
on the future generations is not rdG but only rcdG.
It can readily be seen that the above result is not limited to the case we have
explicitly discussed so far, in which the deficit arises from an increase in